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Why Public Pensions Are Doomed

Public-sector pensions will disappear in the near future.

Not so long ago, millions of workers could count on their employers to provide monthly pensions for them after they retired. But for the private sector, pension plans for new employees have almost entirely disappeared, and even long-tenured workers have had their pension plans frozen or cut.

Even after corporate America began clamping down on its pension obligations, the public sector continued offering traditional pensions to government workers. Recently, though, tight budgets at the state and local level have forced government employers to reconsider whether they, too, need to follow the private sector toward eliminating pensions in favor of defined-contribution plans like 401(k)s.

A sea change for retirement savingWorkers who work for private employers have had to deal with all sorts of challenges in planning for their retirement. Here are just a few examples:

Several years ago, IBM(NYSE: IBM), Verizon(NYSE: VZ), and many other companies froze their pension plans for large portions of their respective workforces. The moves allowed current employees to keep the benefits they had already earned, but stopped them from earning additional benefits in the future. New workers wouldn't be eligible to participate in the frozen pension plans.

After bankruptcy proceedings, some employers, including US Airways(NYSE: LCC) and the predecessor to the United division of United Continental(NYSE: UAL), simply terminated their pension plans entirely. The government's Pension Benefit Guaranty Corporation stepped in to restore some benefits, but many workers didn't get everything they would have received if the pension plan had continued in force.

Various employers have taken a variety of other steps. Hershey(NYSE: HSY) closed its pension plan to new workers several years ago. DuPont(NYSE: DD) and Motorola Solutions(NYSE: MSI), meanwhile, actually changed the formulas their pension plans used to calculate benefits. In some cases, that led to reduced payments for retirees.

Yet even as private-sector workers lost pension benefits, many public employees continued on as usual. Now, though, governments are facing many of the same challenges that their private-business counterparts previously faced with pension liabilities. That partly explains the recent move among states to consider switching to 401(k)-like plans.

Desperate measuresAccording to the New York Times, many states have either made or are considering changes to their pension systems. Michigan, Ohio, and Utah are among those that have already made at least partial switchovers to 401(k)-style retirement plans, while Kentucky and Oklahoma are among others that are looking closely at moves.

With budget shortfalls in many states, workers question whether pension benefits will be there at retirement time. Late last year, one small town in Alabama chose to allow its pension fund to run out of money rather than taking steps to shore up the plan with additional contributions. That case may serve as the first of many similar situations in larger cities and towns across the country in the years to come.

But is it fair?Public sector employees could argue that they relied on generous pension benefits as a trade-off for accepting lower pay to work in public-sector jobs. Although that's undoubtedly true for some employees, high-profile stories about former government workers retiring young on full six-figure pensions have drawn attention away from rank-and-file public employees with more modest pensions.

Regardless of what happens to current workers, new hires in government jobs can soon expect to face the same responsibility to manage their own retirement savings as their peers in the private sector. Government officials have simply proven unable to understand the long-term financial repercussions of promising pension benefits to workers.

Although some workers would undoubtedly prefer to have their pensions taken care of for them, the best solution for workers, government employers, and taxpayers going forward is to stop government entities from making the mistakes of granting lucrative pension benefits in the first place. It's likely too late to fix the promises that they've already made, and going forward, removing those benefits will make public-sector jobs less attractive to potential employees. But at the very least, drawing the line in the sand here will prevent future workers from ushering in a repeat of the current budget crisis, in which unrealistic expectations about the capacity for government employers to give retirement benefits to their employees has caused so much strife.

What do you think about the public pension debate? Weigh in with a comment below.

Be sure to tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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